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The risk is in financial contagion. The economy can handle individual firms going bankrupt - they'll just get replaced by other firms. The problem is when cre

The risk is in financial contagion. The economy can handle individual firms going bankrupt - they'll just get replaced by other firms. The problem is when creditors start taking haircuts and going bankrupt themselves. At that point, things that people thought were secure assets (like, say, their bank accounts) suddenly get called into question, and markets lock up because of panic. In 2008 we thought that the problem was contained to the subprime housing market, and once the Fed started supporting that market people breathed a sigh of relief and there was a rally and recovery from March-May. It wasn't until first Bear Stearns and then Lehman Brothers failed that people realized we were in a crisis. These were centuries-old, multi-hundred-billion-dollars institutions. The idea that they could cease to exist was unthinkable to anyone not actively looking at their balance sheet and doing the math, which is why there was such a panic when they did cease to exist.

sigstoat 7y ago
> At that point, things that people thought were secure assets (like, say, their bank accounts) what possible justification is there to be worried about their FDIC-insured bank accounts? even sticking that in as an off-hand comment is spreading FUD.
- cstejerean 7y ago
  This is describing what happened in 2008. The FDIC limit was only $100,000 but many people assumed they had no reason to worry about the security of higher balances in excess of the FDIC limits. So when big stable banks started to fail or were at risk of failing that caught folks by surprise. As a result: > The Emergency Economic Stabilization Act of 2008 is signed on Oct. 3, 2008. This temporarily raises the basic limit of federal deposit insurance coverage from $100,000 to $250,000 per depositor. The limit was subsequently permanently raised. So with a limit of $250,000 there’s less reason to worry about bank accounts today. But the important point remains, what causes panic is when things that everyone assumes to be safe turn out to no longer be so safe after all.
  - lonelappde 7y ago
    Who assumes that a bank account over the FDIC limit is safe? And who cares if rich people take a haircut in a recession?
    - dodobirdlord 7y ago
      People who want to head off a financial panic. A compounding panic makes it difficult to address the underlying cause of financial issues that triggered the panic in the first place.
koheripbal 7y ago
> The problem is when creditors start taking haircuts and going bankrupt themselves. But this isn't really a risk to the broader market, because the government has already made it plain that it's going to backstop the liquidity to prevent any liquidity crisis, from buying commercial debt, to even buying equity. ...so if the gov't is the lender of last resort, then your argument doesn't make sense because. Lehman Brothers going under is something the Fed has said it will not let happen again. Particularly in this scenario where bad debt is due to a pure externality. ...not to mention that people's bank accounts are protected by FDIC, and equity/retirement accounts are protected by a similar program. Not that it really matters, because the banks are all much better capitalized than they were in 2008. The real danger here is the potential for snap-back inflation (in a stagflation scenario), which I'd argue actually makes equities MORE attractive, not less - since stocks are inherently inflation protected.
- UncleOxidant 7y ago
  How did the markets do during the 70's stagflation? Not so well.
  - koheripbal 7y ago
    That was fundamentally different because it was caused by an increase in INPUT costs and pre-dates the current monetary system. So it's not a useful comparison.
- panarky 7y ago
  Yes, this is the big unknown at the moment. Governments and central banks will certainly attempt to prevent contagion by buying assets and handing out bailout cash. Does that fix the problem and then we go back to normal? Does it result in Weimar-style hyperinflation? Does it cause negative rates on long-term bonds? I can only think of two historical precedents for guidance on how this might play out. First, Japan's "Lost Decade" (which was really more like 25 years). And second, the 2008 financial collapse. Not sure either of these are directly comparable to the current predicament, though.
- nostrademons 7y ago

sigstoat 7y ago

> At that point, things that people thought were secure assets (like, say, their bank accounts) what possible justification is there to be worried about their FDIC-insured bank accounts? even sticking that in as an off-hand comment is spreading FUD.

cstejerean 7y ago
This is describing what happened in 2008. The FDIC limit was only $100,000 but many people assumed they had no reason to worry about the security of higher balances in excess of the FDIC limits. So when big stable banks started to fail or were at risk of failing that caught folks by surprise. As a result: > The Emergency Economic Stabilization Act of 2008 is signed on Oct. 3, 2008. This temporarily raises the basic limit of federal deposit insurance coverage from $100,000 to $250,000 per depositor. The limit was subsequently permanently raised. So with a limit of $250,000 there’s less reason to worry about bank accounts today. But the important point remains, what causes panic is when things that everyone assumes to be safe turn out to no longer be so safe after all.
- lonelappde 7y ago
  Who assumes that a bank account over the FDIC limit is safe? And who cares if rich people take a haircut in a recession?
  - dodobirdlord 7y ago
    People who want to head off a financial panic. A compounding panic makes it difficult to address the underlying cause of financial issues that triggered the panic in the first place.

koheripbal 7y ago

> The problem is when creditors start taking haircuts and going bankrupt themselves. But this isn't really a risk to the broader market, because the government has already made it plain that it's going to backstop the liquidity to prevent any liquidity crisis, from buying commercial debt, to even buying equity. ...so if the gov't is the lender of last resort, then your argument doesn't make sense because. Lehman Brothers going under is something the Fed has said it will not let happen again. Particularly in this scenario where bad debt is due to a pure externality. ...not to mention that people's bank accounts are protected by FDIC, and equity/retirement accounts are protected by a similar program. Not that it really matters, because the banks are all much better capitalized than they were in 2008. The real danger here is the potential for snap-back inflation (in a stagflation scenario), which I'd argue actually makes equities MORE attractive, not less - since stocks are inherently inflation protected.

UncleOxidant 7y ago
How did the markets do during the 70's stagflation? Not so well.
- koheripbal 7y ago
  That was fundamentally different because it was caused by an increase in INPUT costs and pre-dates the current monetary system. So it's not a useful comparison.
panarky 7y ago
Yes, this is the big unknown at the moment. Governments and central banks will certainly attempt to prevent contagion by buying assets and handing out bailout cash. Does that fix the problem and then we go back to normal? Does it result in Weimar-style hyperinflation? Does it cause negative rates on long-term bonds? I can only think of two historical precedents for guidance on how this might play out. First, Japan's "Lost Decade" (which was really more like 25 years). And second, the 2008 financial collapse. Not sure either of these are directly comparable to the current predicament, though.
nostrademons 7y ago